I've been thinking about naked call lately. Let's say I sell an OTM naked call with a strike of 10. The stock trades at 9.5. The risk is that if the stock shoots past 10, when I am called I have to buy it at the market price, which results in a loss. However, what if after selling the call, I also entered a buy stop order for 10? Then, if the stock hits 10, the stock is purchased and I am covered. Has anyone done this before?
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1Note that a stop order is not guaranteed to buy shares at a price close to the threshold price, so you still have some risk, though prices are more likely to melt down than to melt up.– Mike ScottCommented Aug 5, 2018 at 6:48
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Has anyone done this before?
I'm sure someone has, but it doesn't completely remove any price risk. Suppose you buy it at 10 and it drops to 5? Then you've lost 5 on the stock and have no realized gain on the option (although you could buy back the option cheaply and exit the position).
To completely remove price risk you have to delta hedge. At ATM option generally has a delta of 50%, meaning that the value of the option changes 0.50 for every $1 change in the stock. The downside to delta hedging is you can spend a lot on transaction fees and employ a lot of "buy high, sell low" transactions with a highly volatile stock.
answered Oct 12, 2017 at 13:15
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That is true. I should have mentioned that I am comparing this strategy to the covered call strategy. With a covered call, you have to buy the stock regardless, so downturn still affects you. With a CC, you may end up getting stuck with the stock. With this strategy, the chances of that are lower, as the stock would have to go past the strike and then go back below it. To mitigate for that, after the stock is purchased through the buy stop, you would place a stop loss to protect yourself. Commented Oct 12, 2017 at 14:07
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@RobertChitoiu True, that's effectively the same as a covered call with a different entry price. Commented Oct 12, 2017 at 14:10